News Column

IASIS HEALTHCARE LLC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 14, 2014

The following discussion and analysis of financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements, the notes to our unaudited condensed consolidated financial statements and the other financial information appearing elsewhere in this report. Data for the quarters and nine months ended June 30, 2014 and 2013, have been derived from our unaudited condensed consolidated financial statements. References herein to "we," "our" and "us" are to IASIS Healthcare LLC and its subsidiaries. References herein to "IAS" are to IASIS Healthcare Corporation, our parent company.



FORWARD LOOKING STATEMENTS

Some of the statements we make in this report are forward-looking within the meaning of the federal securities laws, which are intended to be covered by the safe harbors created thereby. Those forward-looking statements include all statements that are not historical statements of fact and those regarding our intent, belief or expectations including, but not limited to, the discussions of our operating and growth strategy (including possible acquisitions and dispositions), financing needs, projections of revenue, income or loss, capital expenditures and future operations. Those risks and uncertainties include, among others, changes in governmental healthcare programs that could reduce our revenues, including the impact of sequestration; the uncertain impact of federal health reform; the possibility of Health Choice Arizona, Inc.'s ("Health Choice" or the "Plan"), contract with the Arizona Health Care Cost Containment System ("AHCCCS") being discontinued and changes in the payment structure under that contract, as well as an inability to control costs at Health Choice; shifts in payor mix from commercial and managed care payors to Medicaid and managed Medicaid; our ability to retain and negotiate reasonable contracts with managed care plans; a growth in the level of uncompensated care at our hospitals; our ability to recruit and retain quality physicians and medical professionals; competition from other hospitals and healthcare providers impacting our patient volume; our failure to continually enhance our hospitals with the most recent technological advances in diagnostic and surgical equipment; the federal health reform law's significant restrictions on hospitals that have physician owners; a failure of our information systems that would adversely affect our ability to properly manage our operations; failure to effectively and timely implement electronic health record systems; claims brought against our facilities for malpractice, product liability and other legal grounds; difficulties with the integration of acquisitions that may disrupt our ongoing operations; our dependence on key management personnel; potential responsibilities and costs under environmental laws; the possibility of a decline in the fair value of our reporting units that could result in a material non-cash charge to earnings; the risks and uncertainties related to our ability to generate sufficient cash to service our existing indebtedness; our substantial level of indebtedness; the possibility of an increase in interest rates, which would increase the cost of servicing our debt; and the risks associated with us being owned by equity sponsors who have the ability to control our financial decisions. Forward-looking statements involve known and unknown risks and uncertainties that may cause actual results in future periods to differ materially from those anticipated in the forward-looking statements. Those risks and uncertainties, among others discussed in this report, are detailed in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013, filed with the Securities and Exchange Commission (the "SEC"). Although we believe that the assumptions underlying the forward-looking statements contained in this report are reasonable, any of these assumptions could prove to be inaccurate and, therefore, there can be no assurance that the forward-looking statements included in this report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included in this report, you should not regard the inclusion of such information as a representation by us or any other person that our objectives and plans will be achieved. We undertake no obligation to publicly release any revisions to any forward-looking statements contained herein to reflect events and circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events. EXECUTIVE OVERVIEW We are a leading provider of high quality, affordable healthcare services primarily in high-growth urban and suburban markets. As of June 30, 2014, we owned or leased 16 acute care hospital facilities and one behavioral health hospital, with a total of 3,778 licensed beds, several outpatient service facilities, and more than 137 physician clinics. We operate our hospitals with a strong community focus by offering and developing healthcare services targeted to the needs of the markets we serve, promoting strong relationships with physicians and working with local managed care plans. We operate in various regions, including: Salt Lake City, Utah; Phoenix, Arizona; five cities in Texas, including Houston and San Antonio; West Monroe, Louisiana; and Las Vegas, Nevada.



We also own and operate Health Choice, a provider-owned, managed care organization and insurer that delivers healthcare services to over 266,000 members through multiple health plans, integrated delivery systems and managed care solutions. The Plan is headquartered in Phoenix, Arizona.

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In May 2014, Health Choice entered into an agreement with Humana Medical Plan, Inc. ("Humana"), under which Health Choice will provide administrative and managed care services to approximately 80,000 Humana managed Medicaid plan members in the state of Florida. During the quarter and nine months ended June 30, 2014, we incurred $2.0 million and $3.0 million, respectively, in startup related costs associated with Health Choice's new third-party administration and management services organization business.

Significant Industry Trends

The following sections discuss recent trends that we believe are significant factors in our current and/or future operating results and cash flows. Certain of these trends apply to the entire acute care hospital industry, while others may apply to us more specifically. These trends could be short-term in nature or could require long-term attention and resources. While these trends may involve certain factors that are outside of our control, the extent to which these trends affect our hospitals and health plan operations and our ability to manage the impact of these trends play vital roles in our current and future success. In many cases, we are unable to predict what impact, if any, these trends will have on us. The Impact of Health Reform The Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (collectively, the "Health Reform Law") expands coverage of previously uninsured individuals, largely through expansion of Medicaid coverage and establishment of insurance exchanges ("Exchanges") where individuals may purchase coverage. The Health Reform Law also contains an "individual mandate" that imposes financial penalties on individuals who fail to carry health insurance and employers that do not provide health insurance. In addition, the Health Reform Law reforms certain aspects of health insurance, reduces government reimbursement rates, expands existing efforts to tie Medicare and Medicaid payments to performance and quality, places restrictions on physician-owned hospitals and contains provisions intended to strengthen fraud and abuse enforcement. As of April 15, 2014, the federal government has released information indicating that approximately 8.5 million individuals have enrolled in healthcare coverage through the Exchanges. Of those enrolled, the federal government states that approximately 80% of those have paid the related premiums, and 83% have selected plans including financial assistance. While the most significant provisions of the Health Reform Law that result in reducing the number of uninsured individuals generally became effective January 1, 2014, the employer mandate, which requires companies with 50 or more employees to provide health insurance or pay fines, as well as insurer reporting requirements, has been delayed until January 1, 2015. For employers with 50 to 99 employees, this requirement has been further delayed until January 1, 2016. Additionally, a number of state governors and legislatures, including Texas and Louisiana, have chosen not to participate in the expanded Medicaid program at this time; however, these states could choose to implement the expansion at a later date. While some states have currently chosen not to participate, other states such as Arizona and Nevada have expanded their Medicaid programs. Because of the many variables involved, including the law's complexity, the lack of implementing regulations or interpretive guidance for all of its provisions, gradual and partially delayed implementation, court challenges, possible reductions in funding by the U.S. Congress ("Congress") and future reductions in Medicare and Medicaid reimbursement, the impact of the Health Reform Law, including how individuals and businesses will respond to the new choices and obligations under the law, is not yet fully known. We believe, however, that trends toward pay-for-performance reimbursement models focused on quality and cost control, which are encouraged by the Health Reform Law, are taking hold among private health insurers and will continue to do so. One notable provision of the Health Reform Law is an annual health insurer fee ("HIF") that applies to most health plans, including commercial health plans and Medicaid managed care plans like Health Choice. While characterized as a "fee" in the text of the Health Reform Law, the intent of Congress was to impose a broad based health insurance industry excise tax, with the understanding that the tax could be passed on to consumers, most likely through higher commercial insurance premiums. However, because Medicaid is a government-funded program, Medicaid health plans have no alternative but to look to their respective state partners for payment to offset the impact of this tax. We continue to work with our state partners to obtain reimbursement for the economic impact of this fee, and currently anticipate to be reimbursed in full. Currently, we project that our HIF payable by September 30, 2014 will be approximately $7.9 million.



Two Midnight Rule

In the Medicare program's hospital inpatient prospective payment system ("IPPS") final rule for federal fiscal year 2014, the Centers for Medicare and Medicaid Services ("CMS") issued the "two midnight rule," which revised its longstanding guidance to hospitals and physicians relating to when hospital inpatient admissions are deemed to be reasonable and necessary for payment under Medicare Part A. Under the two midnight rule, in addition to services that are designated as inpatient-only, surgical procedures, diagnostic tests and other treatments are generally appropriate for inpatient hospital admission and payment under Medicare Part A when the physician (i) expects the beneficiary to require a stay that crosses at least two midnights and (ii) admits the beneficiary to the hospital based upon that expectation. Conversely, hospital stays in which the physician expects the beneficiary to require care that spans less than two midnights are generally inappropriate for payment under Medicare Part A, and should be treated and billed as outpatient services under Part B. While the IPPS final rule for federal fiscal year 2014 became effective on October 1, 2013, CMS initially indicated that, for a period of 90 days after the effective date of the rule, it would not permit recovery auditors and other Medicare review contractors to review inpatient admissions of one midnight or less that began between October 1, 2013 and December 31, 2013. CMS subsequently extended that delay to inpatient admissions that occur on or prior to September 30, 2014. CMS did, however, instruct Medicare Administrative Contractors ("MACs") to review, on a pre-payment basis, a small sample (approximately 10 - 25) of inpatient hospital claims relating to admissions that occur between March 31, 2014 and September 30, 2014, and that span less than two midnights after admission in order to determine each hospital's compliance with the new inpatient admission and medical review criteria. Hospitals can rebill denied inpatient hospital admissions in accordance with the rule. 35



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On April 1, 2014, President Obama signed the Protecting Access to Medicare Act of 2014 (the "PAM Act") into law. Among other things, the PAM Act extends the delay of the enforcement of the two midnight rule by recovery auditor and other Medicare review contractors through March 31, 2015, and authorizes CMS to continue to allow MACs to review, on a pre-payment basis, a small sample of inpatient hospital claims relating to admissions that span less than two midnights and that occur between March 31, 2014, and March 31, 2015, in order to determine hospital compliance with the new inpatient admission and medical review criteria. We cannot predict whether Congress or CMS will further delay the review of inpatient admissions of one midnight or less by recovery auditors or other Medicare review contractors, the impact that any such reviews will have on our business and results of operations, or when they are allowed by CMS. In addition, legislation has been introduced in Congress that, among other things, would both generally prohibit Medicare review contractors from denying claims due to the length of a patient's stay or a determination that services could have been provided in an outpatient setting and require CMS to develop a new payment methodology for services that are provided during short inpatient hospital stays. Federal lawsuits have also been filed challenging the two midnight rule primarily on the grounds that the implementation of the rule itself, and the payment reduction associated with the rule (i.e., 0.2% IPPS payment reduction to hospitals) violate the Administrative Procedure Act. We cannot predict whether legislation will be adopted or, if adopted, the amount of reimbursement that would be paid under any alternative payment methodology that would be developed by CMS. We also cannot predict whether federal court challenges to the two midnight rule will be successful.



Budget Control Act and Sequestration

The Budget Control Act of 2011 (the "BCA") increased the nation's borrowing authority and takes steps to reduce federal spending and the deficit. The deficit reduction portion of the BCA imposes caps, which began in federal fiscal year 2012, that reduce discretionary spending by more than $900 billion over ten years. The BCA also requires automatic spending reductions of $1.2 trillion for federal fiscal years 2013 through 2021, minus any deficit reductions enacted by Congress and debt service costs. The spending reductions have been extended through 2024. These automatic spending reductions are commonly referred to as "sequestration." The spending reductions are split evenly between defense and non-defense discretionary spending, although certain programs (including Medicaid and Children's Health Insurance Programs ("CHIP")), are exempt from these automatic spending reductions, and Medicare expenditures cannot be reduced by more than two percent. Sequestration began on March 1, 2013, with CMS imposing a two percent reduction on Medicare claims beginning April 1, 2013. We are unable to predict what other deficit reduction initiatives may be proposed by the President or Congress or whether the President and the Congress will restructure or suspend sequestration. It is possible that changes in the law to end or restructure sequestration will result in greater spending reductions than currently required by the BCA.



Value-Based Reimbursement

The trend in the healthcare industry continues towards value-based purchasing of healthcare services. These value-based purchasing programs include both public reporting and financial incentives tied to the quality and efficiency of care provided by facilities. The Health Reform Law expands the use of value-based purchasing initiatives in federal healthcare programs. We expect programs of this type to become more common in the healthcare industry. In addition, managed care organizations are implementing programs that condition payment on performance against specified measures. The quality measurement criteria used by managed care and commercial payors may be similar to or even more stringent than Medicare requirements. As we expect these trends towards value-based purchasing of healthcare services by Medicare and other payors to continue, we believe that our position as a high-quality, low cost provider in certain of our markets will prove beneficial as we continue to move towards a quality and value-based reimbursement system. Because of these trends, if we are unable to meet or exceed quality of care standards in our facilities, our operating results could be significantly impacted in the future.



State Medicaid Budgets

Over recent years, the states in which we operate experienced budget constraints as a result of increased costs and lower than expected tax collections. Health and human services programs, including Medicaid and similar programs, represent a significant portion of state budgets. The states in which we operate responded to these budget concerns, by decreasing funding for Medicaid and other healthcare programs or by making structural changes that resulted in a reduction in hospital reimbursement. In addition, many states have received waivers from CMS in order to implement or expand managed Medicaid programs. 36



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Texas

The Texas legislature and the Texas Health and Human Services Commission ("THHSC") recommended expanding Medicaid managed care enrollment in the state, and in December 2011, CMS approved a five-year Medicaid waiver that: (1) allows Texas to expand its Medicaid managed care program while preserving hospital funding; (2) provides incentive payments for improvements in healthcare delivery; and (3) directs more funding to hospitals that serve large numbers of uninsured patients. Certain of our acute care hospitals currently receive supplemental Medicaid reimbursement, including reimbursement from programs for participating private hospitals that enter into indigent care affiliation agreements with public hospitals or county governments in the state of Texas. Under the CMS-approved programs, affiliated hospitals, including our Texas hospitals, have expanded the community healthcare safety net by providing indigent healthcare services. Revenue recognized under these Texas private supplemental Medicaid reimbursement programs for the quarter and nine months ended June 30, 2014, was $17.6 million and $53.6 million, respectively, compared to $16.5 million and $45.7 million in the prior year periods. Under the Medicaid waiver, funds are distributed to participating hospitals based upon both the costs associated with providing care to individuals without third party coverage and the investment made to support coordinating care and quality improvements that transform the local communities' care delivery systems. The responsibility to coordinate and develop plans that address the concerns of the local delivery care systems, including improved access, quality, cost effectiveness and coordination will be controlled primarily by government-owned public hospitals that serve the surrounding geographic areas. Complexities of the underlying methodologies in determining the funding for the state's Medicaid supplemental reimbursement programs, along with a lack of sufficient resources at THHSC to administer the programs, has resulted in a delay in related reimbursements. As of June 30, 2014, we had $73.6 million in receivables due to our Texas hospitals in connection with these supplemental Medicaid reimbursement programs, including amounts due under the Texas Medicaid Disproportionate Share Hospital program ("Texas Medicaid DSH"), compared to receivables of $66.8 million at September 30, 2013. During the quarter ended June 30, 2014, we received cash of $37.0 million from the state of Texas related to the supplemental Medicaid reimbursement programs. The THHSC has released proposed rules to change the Texas Medicaid DSH methodology for the state's fiscal year 2014 and 2015. While changes to the Texas Medicaid DSH methodology have been proposed, details regarding its computation for the state's upcoming fiscal year have not yet been finalized. Because deliberations regarding the Texas Medicaid DSH program are ongoing, we are unable to estimate the financial impact, if any, that proposed program changes may have on our results of operations. Texas has appropriated $160.0 million for fiscal year 2014 and $140.0 million for fiscal year 2015 to stabilize and improve the Texas Medicaid DSH program, including providing rate adjustments to recognize improvements in quality of patient care, the most appropriate use of care, and patient outcomes. These appropriations provide that the funding is contingent on "measurable progress" by THHSC toward a long-term plan. Funds appropriated for in 2015 may not be spent before the plan is finalized. During the quarter and nine months ended June 30, 2014, we recognized $7.5 million and $22.6 million, respectively, in Texas Medicaid DSH revenues, compared to $7.1 million and $21.4 million in the prior year periods.



Arizona

Beginning in July 2011, in an effort to control its budgeted expenditures and balance its budget, the state of Arizona implemented a plan to reduce its eligible Medicaid beneficiaries, particularly childless adults. Following implementation of this plan by the state of Arizona, Health Choice experienced a significant decline through the end of our fiscal year 2013 in its enrollees, premium revenue and earnings. Effective January 1, 2014, Arizona expanded its Medicaid program under the Health Reform Law, which includes increased eligibility for adults, children and pregnant women, and the restoration of eligibility to childless adults that was previously eliminated. The expansion of the state's Medicaid program under the Health Reform Law could potentially result in the addition of approximately 370,000 people to its Medicaid rolls. As a result of the Medicaid expansion, enrollment at Health Choice increased 10.4% for the quarter ended June 30, 2014, compared to the prior year quarter. In addition, in connection with the expanded Medicaid coverage, the state implemented a provider assessment effective January 1, 2014, to fund a portion of the expanded eligibility related to the childless adult population. During the quarter and nine months ended June 30, 2014, we incurred $1.3 million and $2.6 million, respectively, in provider tax assessments.



If additional Medicaid program changes are implemented in the future in Arizona or other states in which we operate, our revenue and earnings could be significantly impacted.

Physician Alignment and Clinical Integration

In an effort to meet community needs and address coverage issues, we have made significant investments in order to align with physicians through various recruitment and employment strategies, as well as alternative means of alignment such as our formation of provider networks in certain markets. We believe that physician alignment promotes clinical integration, enhances quality of care and makes us more efficient and competitive in a healthcare environment trending toward value-based purchasing and pay-for-performance. As we continue to focus on our physician alignment and integration strategies, we face significant competition for skilled physicians in certain of our markets as more hospital providers adopt a physician staffing model approach, coupled with a general 37



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shortage of physicians across most specialties. This increased competition has resulted in efforts by managed care organizations to align with certain provider networks in the markets in which we operate. In response, we have formed our own provider networks in certain markets that include both employed and non-affiliated physicians, providing the infrastructure through which we are able to contract more efficiently with commercial payors, position ourselves for value based reimbursement and promote clinical integration. While we expect that employing physicians provides relief on cost pressures associated with on-call coverage and other professional fees, we anticipate the addition of new employed physicians would result in increased labor and other start-up related costs as we integrated the physicians and their related support staff into our healthcare delivery systems. We also face risk from competition for outpatient business. We expect to mitigate this risk through continued focus on our physician employment strategy, the development of new access points of care, our commitment to capital investment in our hospitals, including updated technology and equipment, and our commitment to our quality of care initiatives that some competitors, including individual physicians or physician groups, may not be equipped to implement.



Uncompensated Care

While the amount of uncompensated care, including discounts to the uninsured, bad debts and charity care, we deliver to the communities we serve continues to remain high in comparison to historical levels, we have experienced improvement during the quarter and nine months ended June 30, 2014. During the quarter ended June 30, 2014, our uncompensated care as a percentage of acute care revenue was 20.6%, compared to 23.5% in the prior year quarter. During the nine months ended June 30, 2014, our uncompensated care as a percentage of acute care revenue was 22.3%, compared to 23.9% in the prior year period. We believe the improvement in our uncompensated care as a percentage of acute care revenue can be attributed primarily to the impact of Medicaid expansion in the state of Arizona, which has resulted in lower self-pay volume and revenue for the quarter and nine months ended June 30, 2014, compared to the same prior year periods. During the quarter ended June 30, 2014, our self-pay admissions represented 6.0% of our total admissions, compared to 8.0% in the prior year quarter. During the nine months ended June 30, 2014, our self-pay admissions represented 7.0% of our total admissions, compared to 7.9% in the prior year period. The improvement in our uncompensated care as a percentage of acute care revenue has been mitigated somewhat by the higher acuity levels at which self-pay patients are presenting for treatment through our emergency rooms. Additionally, the declines in our self-pay volume and revenue are being aided by increasing benefits from recent Exchange enrollment, given that certain Exchange enrollees previously were included in the uninsured population. During the quarter ended June 30, 2014, we experienced 305 Exchange related admissions, compared to 103 in the sequential quarter ended March 31, 2014. We would expect uninsured volumes to continue to decline in the near future as the impact of the Health Reform Law is fully realized. However, if we were to experience growth in uninsured volume and revenue, our uncompensated care may increase and our results of operations could be adversely affected. The percentages of our insured and uninsured hospital net receivables are summarized as follows (1): June 30, September 30, 2014 2013 Insured receivables 82.2 % 81.4 % Uninsured receivables 17.8 % 18.6 % Total 100.0 % 100.0 % The percentages of hospital net receivables in summarized aging categories are as follows (1): June 30, September 30, 2014 2013 0 to 90 days 61.0 % 61.8 % 91 to 180 days 20.3 % 20.7 % Over 180 days 18.7 % 17.5 % Total 100.0 % 100.0 %



(1) Excludes hospital receivables retained related to our discontinued Florida

operations.

Adoption of Electronic Health Records ("EHR")

The American Recovery and Reinvestment Act of 2009 ("ARRA") included approximately $26.0 billion in funding for various healthcare information technology ("IT") initiatives, including Medicare and Medicaid incentives for eligible hospitals and professionals to adopt and meaningfully use certified EHR technology ("EHR Incentive Programs"). In addition, eligible providers that fail to demonstrate meaningful use of certified EHR technology will be subject to reduced payments from Medicare, beginning in federal fiscal year 2015 for eligible hospitals and calendar year 2015 for eligible professionals. Implementation of the EHR Incentive 38



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Programs has been divided into three stages with increasing requirements for participation. Stage 1 requires providers to meet meaningful use objectives specified by CMS, which include electronically capturing health information in structured format, tracking key clinical conditions for coordination of care purposes, implementing clinical decision support tools to facilitate disease and medication management, using EHRs to engage patients and families, and reporting clinical quality measures and public health information. Our hospitals, as well as a number of our physician clinics, substantially met the Stage 1 requirements in our fiscal year 2012. Stage 2 introduces several new meaningful use measures, as well as imposes stricter requirements on certain existing Stage 1 measures. Providers must achieve meaningful use under the Stage 1 criteria before advancing to Stage 2 and are required to meet the criteria for the applicable stage based on their first year of attesting to meaningful use. Our hospitals and physician clinics whose first payment year was 2011 and 2012 are required to meet Stage 2 criteria beginning in 2014. Though we expect to continue to incur certain non-productive and other operating costs, as well as additional investments in hardware and software, we believe our historical investments in advanced clinical and other information systems, as well as quality of care programs, provides a solid platform to build upon for timely compliance with the healthcare IT initiatives and requirements of ARRA. During the quarter and nine months ended June 30, 2014, we recognized Medicare and Medicaid EHR incentives totaling $2.8 million and $10.2 million, respectively, compared to $4.8 million and $11.2 million in the prior year periods.



Revenue and Volume Trends

Total net revenue for the quarter ended June 30, 2014, increased 12.4% to $673.2 million, compared to $599.1 million in the prior year quarter. Total net revenue for the nine months ended June 30, 2014, increased 8.4% to $1.94 billion, compared to $1.79 billion in the prior year period. Total net revenue is comprised of acute care revenue, which is recorded net of the provision for bad debts, and premium revenue. Acute care revenue contributed $13.5 million to the increase in total net revenue for the quarter ended June 30, 2014, compared to the prior year quarter, while premium revenue at Health Choice contributed $60.5 million for the same period. Acute care revenue contributed $41.0 million to the increase in total net revenue for the nine months ended June 30, 2014, compared to the prior year period, while premium revenue at Health Choice contributed $102.9 million for the same period.



Acute Care Revenue

Acute care revenue is comprised of net patient revenue and other revenue. A large percentage of our hospitals' net patient revenue consists of fixed payment, discounted sources, including Medicare, Medicaid and managed care organizations. Reimbursement for Medicare and Medicaid services are often fixed regardless of the cost incurred or the level of services provided. Similarly, a greater percentage of the managed care companies we contract with reimburse providers on a fixed payment basis regardless of the costs incurred or the level of services provided. Net patient revenue is reported net of discounts and contractual adjustments. The contractual adjustments principally result from differences between the hospitals' established charges and payment rates under Medicare, Medicaid and various managed care plans. Additionally, discounts and contractual adjustments result from our uninsured discount and charity care programs. Acute care revenue is reported net of the provision for doubtful accounts. Other revenue includes medical office building rental income and other miscellaneous revenue. Admissions decreased 3.1% and 3.4% for the quarter and nine months ended June 30, 2014, respectively, compared to the same prior year periods. These decreases are reflective of a decline in Medicare 1-day stays, an industry-wide decline in inpatient utilization, and a continued shift towards outpatient services. In addition, respiratory or flu-related volumes declined for the nine months ended June 30, 2014, as compared to the same prior year periods. Adjusted admissions increased 1.9% and 0.7% for the quarter and nine months ended June 30, 2014, compared to the same prior year periods. For the quarter and nine months ended June 30, 2014, our outpatient volumes were positively impacted by increases in outpatient surgeries of 4.5% and 5.1%, respectively, compared to the same prior year periods. Additionally, emergency room visits for the quarter ended June 30, 2014 increased 3.2% compared to the prior year, while decreasing 0.9% in the nine months ended June 30, 2014, compared to the prior year period. The following table provides the sources of our hospitals' gross patient revenue by payor: Quarter Ended Nine Months Ended June 30, June 30, 2014 2013 2014 2013 Medicare 27.2 % 29.8 % 27.8 % 29.2 % Managed Medicare 14.6 % 14.9 % 14.7 % 14.4 % Medicaid and managed Medicaid 22.3 % 18.3 % 21.4 % 20.2 % Managed care and other 30.5 % 29.9 % 30.0 % 29.2 % Self-pay 5.4 % 7.1 % 6.1 % 7.0 % Total 100.0 % 100.0 % 100.0 % 100.0 % 39



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The following table provides the sources of our hospitals' net patient revenue by payor before the provision for bad debts:

Quarter Ended Nine Months Ended June 30, June 30, 2014 2013 2014 2013 Medicare 20.3 % 20.5 % 20.6 % 21.3 % Managed Medicare 10.1 % 9.8 % 10.1 % 10.0 % Medicaid and managed Medicaid 13.4 % 12.0 % 12.7 % 12.2 % Managed care and other 40.9 % 38.4 % 39.5 % 37.9 % Self-pay 15.3 % 19.3 % 17.1 % 18.6 % Total 100.0 % 100.0 % 100.0 % 100.0 % As noted in the above tables, our gross and net patient revenue by payor is experiencing a shift from self-pay to Medicaid and managed Medicaid and managed care payors. This shift is primarily a result of Arizona's expansion of its Medicaid program under Health Care Reform, which become effective January 1, 2014, the initial benefit being experienced as Exchange enrollees begin accessing the healthcare system and the early signs of improvement in the underlying economic fundamentals in the markets we serve. Net patient revenue per adjusted admission, which includes the impact of the provision for bad debts, increased 1.3% and 2.5% for the quarter and nine months ended June 30, 2014, compared to the same prior year periods. See "Item 1 - Business - Sources of Acute Care Revenue" and "Item 1 - Business - Government Regulation and Other Factors" included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013, filed with the SEC on December 20, 2013, for a description of the types of payments we receive for services provided to patients enrolled in the traditional Medicare plan, managed Medicare plans, Medicaid plans, managed Medicaid plans and managed care plans. In those sections, we also discussed the unique reimbursement features of the traditional Medicare plan, including the annual Medicare regulatory updates published by CMS that impact reimbursement rates for services provided under the plan. The future potential impact to reimbursement for certain of these payors under the Health Reform Law is also addressed in such Annual Report on Form 10-K.



Premium Revenue

Health Choice contracts with state Medicaid programs in Arizona and Utah to provide specified health services to qualified Medicaid enrollees through contracted providers. Most of its premium revenue is derived through a contract with AHCCCS, the state agency that administers Arizona'sMedicaid program. The contract requires Health Choice to arrange for healthcare services for enrolled Medicaid patients in exchange for fixed monthly premiums, based upon negotiated per capita member rates, and supplemental payments from AHCCCS. Health Choice also contracts with CMS to provide coverage as a Medicare Advantage Prescription Drug ("MAPD") Special Needs Plan ("SNP"). This contract allows Health Choice to offer Medicare and Part D drug benefit coverage to new and existing dual-eligible members (i.e., those that are eligible for Medicare and Medicaid). In accordance with CMS regulations, SNPs are now expected to meet additional requirements, including requirements relating to model of care, cost-sharing, disclosure of information and reporting of quality measures. Premium revenue generated by Health Choice represented 29.8% and 27.1% of our consolidated net revenue for the quarter and nine months ended June 30, 2014, respectively, compared to 23.3% and 23.6% in the same prior year periods. 40



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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

A summary of significant accounting policies is disclosed in Note 2 to the consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013. Our critical accounting policies are further described under the caption "Critical Accounting Policies and Estimates" in Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013. There have been no changes in the nature of our critical accounting policies or the application of those policies since September 30, 2013. SELECTED OPERATING DATA



The following table sets forth certain unaudited operating data from continuing operations for each of the periods presented.

Quarter Ended Nine Months Ended June 30, June 30, 2014 2013 2014 2013 Acute Care Number of acute care hospital facilities at end of period 16 16 16 16 Licensed beds at end of period (1) 3,778 3,804 3,778 3,804 Average length of stay (days) (2) 5.07 5.09 5.15 5.10 Occupancy rates (average beds in service) 48.5 % 49.7 % 49.6 % 50.6 % Admissions (3) 26,307 27,155 79,796 82,643 Adjusted admissions (4) 49,103 48,175 144,790 143,750 Patient days (5) 133,488 138,108 409,923 421,159 Adjusted patient days (4) 249,162 245,015 743,804 732,569 Net patient revenue per adjusted admission (6) $ 9,509$ 9,391$ 9,611$ 9,376 Health Choice Covered lives (7) 213,032 186,111 213,032 186,111 Medical loss ratio (8) 84.5 % 84.8 % 84.8 % 83.8 %



(1) Includes St. Luke's Behavioral Hospital in Phoenix, Arizona.

(2) Represents the average number of days that a patient stayed in our hospitals.

(3) Represents the total number of patients admitted to our hospitals for stays

in excess of 23 hours. Management and investors use this number as a general

measure of inpatient volume.

(4) Adjusted admissions and adjusted patient days are general measures of

combined inpatient and outpatient volume. We compute adjusted

admissions/patient days by multiplying admissions/patient days by gross

patient revenue and then dividing that number by gross inpatient revenue.

(5) Represents the number of days our beds were occupied by inpatients over the

period.

(6) Includes the impact of the provision for bad debts as a component of revenue.

(7) Represents total lives enrolled across all health plan product lines.

Includes dual-eligible lives, which are members eligible for Medicare and

Medicaid benefits, under Health Choice's contract with CMS to provide

coverage as a MAPD SNP totaling 8,006 and 4,310 as of June 30, 2014 and 2013,

respectively.

(8) Represents medical claims expense as a percentage of premium revenue,

including claims paid to our hospitals. 41



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Table of Contents RESULTS OF OPERATIONS SUMMARY Consolidated The following table sets forth, for the periods presented, the results of our consolidated operations expressed in dollar terms and as a percentage of net revenue. Such information has been derived from our unaudited condensed consolidated statements of operations. Quarter Ended Quarter Ended Nine Months Ended Nine Months Ended June 30, 2014 June 30, 2013 June 30, 2014 June 30, 2013 ($ in thousands): Amount Percentage

Amount Percentage Amount Percentage Amount Percentage Net revenue Acute care revenue before provision for bad debts $ 556,318$ 555,413$ 1,692,779$ 1,636,836 Less: Provision for bad debts (83,437 ) (96,090 ) (281,931 ) (267,014 ) Acute care revenue 472,881 70.2 % 459,323 76.7 % 1,410,848 72.9 % 1,369,822 76.4 % Premium revenue 200,281 29.8 % 139,804 23.3 % 524,995 27.1 % 422,059 23.6 % Net revenue 673,162 100.0 % 599,127 100.0 % 1,935,843 100.0 % 1,791,881 100.0 % Costs and expenses Salaries and benefits 234,546 34.8 % 219,896 36.7 % 701,983 36.3 % 670,286 37.4 % Supplies 80,411 11.9 % 79,462 13.3 % 243,437 12.6 % 240,724 13.4 % Medical claims 165,943 24.7 % 116,640 19.5 % 436,754 22.6 % 348,556 19.5 % Rentals and leases 18,796 2.8 % 13,992 2.3 % 56,429 2.9 % 40,635 2.3 % Other operating expenses 114,933 17.1 % 106,456 17.8 % 325,012 16.8 % 309,987 17.3 % Medicare and Medicaid EHR incentives (2,790 ) (0.4 %) (4,827 ) (0.8 %) (10,233 ) (0.5 %) (11,209 ) (0.6 %) Interest expense, net 32,275 4.8 % 32,771 5.4 % 98,325 5.2 % 99,987 5.5 % Depreciation and amortization 23,276 3.4 % 24,492 4.1 % 71,860 3.6 % 72,606 4.1 % Management fees 1,250 0.2 % 1,250 0.2 % 3,750 0.2 % 3,750 0.2 % Total costs and expenses 668,640 99.3 % 590,132 98.5 % 1,927,317 99.6 % 1,775,322 99.1 % Earnings from continuing operations before gain on disposal of assets and income taxes 4,522 0.7 % 8,995 1.5 % 8,526 0.4 % 16,559 0.9 % Gain on disposal of assets, net 332 0.0 % 481 0.1 % 1,100 0.1 % 649 0.1 % Earnings from continuing operations before income taxes 4,854 0.7 % 9,476 1.6 % 9,626 0.5 % 17,208 1.0 % Income tax expense 6,331 0.9 % 3,850 0.7 % 10,198 0.5 % 8,016 0.5 % Net earnings (loss) from continuing operations (1,477 ) (0.2 %) 5,626 0.9 % (572 ) (0.0 %) 9,192 0.5 % Earnings (loss) from discontinued operations, net of income taxes (2,847 ) (0.4 %) (531 ) (0.1 %) 1,821 (0.0 %) 849 0.1 % Net earnings (loss) (4,324 ) (0.6 %) 5,095 0.8 % 1,249 0.0 % 10,041 0.6 % Net earnings attributable to non-controlling interests (2,453 ) (0.4 %) (1,941 ) (0.3 %) (8,857 ) (0.5 %) (3,189 ) (0.2 %) Net earnings (loss) attributable to IASIS Healthcare LLC $ (6,777 ) (1.0 %) $ 3,154 0.5 % $ (7,608 ) (0.5 %) $ 6,852 0.4 % 42



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Acute Care

The following table and discussion sets forth, for the periods presented, the results of our acute care operations expressed in dollar terms and as a percentage of acute care revenue. Such information has been derived from our unaudited condensed consolidated statements of operations. Quarter Ended Quarter Ended Nine Months Ended Nine Months Ended June 30, 2014 June 30, 2013 June 30, 2014 June 30, 2013 ($ in thousands): Amount Percentage Amount Percentage Amount Percentage Amount Percentage Acute care revenue Acute care revenue before provision for bad debts $ 556,318$ 555,413$ 1,692,779$ 1,636,836 Less: Provision for bad debts (83,437 ) (96,090 ) (281,931 ) (267,014 ) Acute care revenue 472,881 99.3 % 459,323 99.6 % 1,410,848 99.4 % 1,369,822 99.6 % Revenue between segments (1) 3,262 0.7 % 1,940 0.4 % 8,539 0.6 % 5,334 0.4 % Total acute care revenue 476,143 100.0 % 461,263 100.0 % 1,419,387 100.0 % 1,375,156 100.0 % Costs and expenses Salaries and benefits 225,785 47.4 % 213,806 46.4 % 678,491 47.8 % 652,666 47.5 % Supplies 80,341 16.9 % 79,422 17.2 % 243,264 17.1 % 240,582 17.5 % Rentals and leases 18,348 3.8 % 13,597 2.9 % 55,264 3.9 % 39,443 2.9 % Other operating expenses 101,706 21.4 % 100,463 21.8 % 296,401 20.9 % 292,488 21.3 % Medicare and Medicaid EHR incentives (2,790 ) (0.6 %) (4,827 ) (1.0 %) (10,233 ) (0.7 %) (11,209 ) (0.8 %) Interest expense, net 32,275 6.8 % 32,771 7.1 % 98,325 6.9 % 99,987 7.2 % Depreciation and amortization 22,244 4.7 % 23,463 5.0 % 68,723 4.8 % 69,510 5.0 % Management fees 1,250 0.3 % 1,250 0.3 % 3,750 0.3 % 3,750 0.3 % Total costs and expenses 479,159 100.7 % 459,945 99.7 % 1,433,985 101.0 % 1,387,217 100.9 % Earnings (loss) from continuing operations before gain on disposal of assets and income taxes (3,016 ) (0.7 %) 1,318 0.3 % (14,598 ) (1.0 %) (12,061 ) (0.9 %) Gain on disposal of assets, net 332 0.1 % 481 0.1 % 1,100 0.1 % 649 0.1 % Earnings (loss) from continuing operations before income taxes $ (2,684 ) (0.6 %) $ 1,799 0.4 % $ (13,498 ) (1.1 %) $ (11,412 ) (0.8 %)



(1) Revenue between segments is eliminated in our consolidated results.

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Quarters Ended June 30, 2014 and 2013

Total acute care revenue - Total acute care revenue for the quarter ended June 30, 2014, was $476.1 million, an increase of $14.8 million or 3.2% compared to $461.3 million in the prior year quarter. The increase in total acute care revenue is comprised primarily of an increase in adjusted admissions of 1.9% and an increase in net patient revenue per adjusted admission of 1.3%. Net adjustments to estimated third-party payor settlements, also known as prior year contractuals, resulted in an increase in total acute care revenue for the quarters ended June 30, 2014 and 2013, of $0.5 million and $3.1 million, respectively. Salaries and benefits - Salaries and benefits expense for the quarter ended June 30, 2014, was $225.8 million, or 47.4% of total acute care revenue, compared to $213.8 million, or 46.4% of total acute care revenue in the prior year quarter. Excluding the impact of stock-based compensation, salaries and benefits expense as a percentage of total acute care revenue was 46.5% for the quarter ended June 30, 2014, compared to 46.1% in the prior year quarter. This increase is due primarily to an increase in employee benefit costs compared to the prior year quarter, partially offset by a 0.1% improvement in contract labor as the result of cost reduction initiatives. Supplies - Supplies for the quarter ended June 30, 2014, were $80.3 million, or 16.9% of total acute care revenue, compared to $79.4 million, or 17.2% of total acute care revenue in the prior year quarter. The improvement in supplies as a percentage of total acute care revenue is the result of a decline in supply intensive surgical procedures as evidenced by a 3.1% decline in inpatient surgeries, as well as the impact of supply cost initiatives that have included improved pricing and more effective utilization. Rentals and leases - Rentals and leases expense for the quarter ended June 30, 2014, was $18.3 million, compared to $13.6 million in the prior year quarter. The increase in rentals and leases expense is primarily due to $4.5 million of additional rent expense in the quarter ended June 30, 2014, resulting from the sale-leaseback of certain hospital real estate, which closed in the fourth quarter of fiscal year 2013. Other operating expenses - Other operating expenses for the quarter ended June 30, 2014, were $101.7 million, or 21.4% of total acute care revenue, compared to $100.5 million, or 21.8% of total acute care revenue in the prior year quarter. Other operating expenses as a percentage of total acute revenue improved primarily due to a decline in professional fees associated with our supplemental Medicaid reimbursement programs in Texas.



Nine Months Ended June 30, 2014 and 2013

Total acute care revenue - Total acute care revenue for the nine months ended June 30, 2014, was $1.42 billion, an increase of $44.2 million or 3.2% compared to $1.38 billion in the prior year period. The increase in total acute care revenue is comprised primarily of an increase in adjusted admissions of 0.7% and an increase in net patient revenue per adjusted admission of 2.5%. Net adjustments to estimated third-party payor settlements, also known as prior year contractuals, resulted in an increase in total acute care revenue for the nine months ended June 30, 2014 and 2013, of $4.8 million and $6.6 million, respectively. Salaries and benefits - Salaries and benefits expense for the nine months ended June 30, 2014, was $678.5 million, or 47.8% of total acute care revenue, compared to $652.7 million, or 47.5% of total acute care revenue in the prior year period. Excluding the impact of stock-based compensation and $3.5 million of compensation expense associated with a special bonus paid to certain members of our leadership team in recognition of the execution of certain recent strategic initiatives, salaries and benefits expense as a percentage of total acute care revenue was 46.9% for the nine months ended June 30, 2014, compared to 47.2% in the prior year period. Supplies - Supplies for the nine months ended June 30, 2014, were $243.3 million, or 17.1% of total acute care revenue, compared to $240.6 million, or 17.5% of total acute care revenue in the prior year period. The improvement in supplies as a percentage of acute care revenue is the result of a decline in supply intensive surgical procedures as evidenced by a 2.5% decline in inpatient surgeries, as well as the impact of supply cost initiatives that have included improved pricing and more effective utilization. Rentals and leases - Rentals and leases expense for the nine months ended June 30, 2014, was $55.3 million, compared to $39.4 million in the prior year period. The increase in rentals and leases expense is primarily due to $13.2 million of additional rent expense in the nine months ended June 30, 2014, resulting from of the sale-leaseback of certain hospital real estate, which closed in the fourth quarter of fiscal year 2013. Other operating expenses - Other operating expenses for the nine months ended June 30, 2014, were $296.4 million, or 20.9% of total acute care revenue, compared to $292.5 million, or 21.3% of total acute care revenue in the prior year period. Other operating expenses as a percentage of total acute care revenue improved primarily due to a decline in professional fees associated with our supplemental Medicaid reimbursement programs in Texas. 44



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Health Choice

The following table and discussion sets forth, for the periods presented, the results of our Health Choice operations expressed in dollar terms and as a percentage of premium revenue. Such information has been derived from our unaudited condensed consolidated statements of operations.

Quarter Ended Quarter Ended Nine Months Ended Nine Months Ended June 30, 2014 June 30, 2013 June 30, 2014 June 30, 2013 ($ in thousands): Amount Percentage Amount Percentage Amount Percentage Amount Percentage Premium revenue Premium revenue $ 200,281 100.0 % $ 139,804 100.0 % $ 524,995 100.0 % $ 422,059 100.0 % Costs and expenses Salaries and benefits 8,929 4.5 % 6,090 4.4 % 23,660 4.5 % 17,620 4.2 % Supplies 70 0.0 % 40 0.0 % 173 0.0 % 142 0.0 % Medical claims (1) 169,205 84.5 % 118,580 84.8 % 445,293 84.8 % 353,890 83.8 % Other operating expenses 13,059 6.5 % 5,993 4.3 % 28,443 5.4 % 17,499 4.1 % Rentals and leases 448 0.2 % 395 0.3 % 1,165 0.3 % 1,192 0.3 % Depreciation and amortization 1,032 0.5 % 1,029 0.7 % 3,137 0.6 % 3,096 0.8 % Total costs and expenses 192,743 96.2 % 132,127 94.5 % 501,871 95.6 % 393,439 93.2 % Earnings before income taxes $ 7,538 3.8 % $ 7,677 5.5 % $ 23,124 4.4 % $ 28,620 6.8 %



(1) Medical claims paid to our hospitals of $3.3 million and $1.9 million for the

quarters ended June 30, 2014 and 2013, respectively, and $8.5 million and

$5.3 million for the nine months ended June 30, 2014 and 2013, respectively,

are eliminated in our consolidated results.

Quarters Ended June 30, 2014 and 2013

Premium revenue - Premium revenue from Health Choice was $200.3 million for the quarter ended June 30, 2014, an increase of $60.5 million or 43.3% compared to $139.8 million in the prior year quarter. The increase in premium revenue is attributable to a 14.5% increase in members, driven by growth in all of our product lines. Enrollment in our Medicare and Medicaid product lines increased 81.4% and 10.4%, respectively, compared to the prior year quarter. Our Medicaid product line has been impacted favorably by the expansion of the Medicaid program in Arizona. Additionally, premium revenue on a per member per month basis for the quarter ended June 30, 2014, compared to the prior year quarter, increased 22.6% as a result of changes in the member mix. We also recognized $4.0 million of revenue related to the new HIF as part of the Health Reform Law. Medical claims - Prior to eliminations, medical claims expense was $169.2 million for the quarter ended June 30, 2014, compared to $118.6 million in the prior year quarter. Medical claims expense as a percentage of premium revenue was 84.5% for the quarter ended June 30, 2014, compared to 84.8% in the prior year quarter. Excluding the impact of the HIF revenue, medical claims as a percentage of premium revenue was 86.2% for the quarter ended June 30, 2014, compared to 84.8% in the prior year quarter. This increase is primarily attributable to additional medical expenses associated with the increase in childless adult members, resulting from the recent expansion of the Medicaid program in Arizona, which typically present for treatment at higher acuity levels. Additionally, we have incurred an increase in pharmacy costs resulting from an increase in specialty drug utilization, including $1.1 million of additional costs associated with a new drug used to cure Hepatitis C. Other operating expenses - Other operating expenses for the quarter ended June 30, 2014, were $13.1 million, or 6.5% of premium revenue, compared to $6.0 million, or 4.3% of premium revenue in the prior year quarter. Other operating expenses increased primarily as a result of $2.0 million in start-up related costs associated with our new third-party administration and management services organization business and $4.0 million in HIF expense.



Nine Months Ended June 30, 2014 and 2013

Premium revenue - Premium revenue from Health Choice was $525.0 million for the nine months ended June 30, 2014, an increase of $102.9 million or 24.4% compared to $422.1 million in the prior year period. The increase in premium revenue is attributable to a 6.2% increase in members, driven by growth in all of our product lines. Enrollment in our Medicare and Medicaid product lines increased 56.6% and 7.5%, respectively, compared to the prior year period. Our Medicaid product line has been impacted favorably by the expansion of the 45



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Medicaid program in Arizona. Premium revenue on a per member per month basis for the nine months ended June 30, 2014, compared to the prior year period, increased 13.5% as a result of changes in the member mix. Additionally, premium revenue for the nine months ended June 30, 2014, compared to the prior year period, increased as a result of additional reimbursement related to primary care physician Medicaid parity payments, which also includes a pass-through component impacting our medical expenses. We also recognized $4.0 million of revenue related to the new HIF as part of the Health Reform Law. Medical claims - Prior to eliminations, medical claims expense was $445.3 million for the nine months ended June 30, 2014, compared to $353.9 million in the prior year period. Medical claims expense as a percentage of premium revenue was 84.8% for the nine months ended June 30, 2014, compared to 83.8% in the prior year period. Excluding the impact of the HIF revenue, medical claims as a percentage of premium revenue was 85.5% for the nine months ended June 30, 2014, compared to 83.8% in the prior year period. This increase is primarily attributable to additional medical expenses associated with the increase in childless adult members, resulting from the recent expansion of the Medicaid program in Arizona, which typically present for treatment at higher acuity levels. Additionally, we have incurred an increase in pharmacy costs resulting from an increase in specialty drug utilization, including $3.8 million of additional costs associated with a new drug used to cure Hepatitis C. Other operating expenses - Other operating expenses for the nine months ended June 30, 2014, were $28.4 million, or 5.4% of premium revenue, compared to $17.5 million, or 4.1% of premium revenue in the prior year period. Other operating expenses increased primarily as a result of $3.0 million in start-up related costs associated with our new third-party administration and management services organization business and $4.0 million in HIF expense.



Income Tax Expense

Quarters ended June 30, 2014 and 2013

For the quarter ended June 30, 2014, we recorded income tax expense of $6.3 million, for an effective tax rate of 130.4%, compared to income tax expense of $3.9 million, for an effective tax rate of 40.6% in the prior year quarter. The increase in the effective tax rate was primarily due to an increase in certain nondeductible expenses including: (1) nondeductible compensation, including stock-based compensation; (2) a $1.1 million expense related to an excess of cumulative compensation deductions over the realized tax benefit upon the exercise of employee stock options; and (3) the HIF imposed by the Health Reform Law beginning in 2014, which is treated as a nondeductible excise tax.



Nine months ended June 30, 2014 and 2013

For the nine months ended June 30, 2014, we recorded income tax expense of $10.2 million, for an effective tax rate of 105.9%, compared to income tax expense of $8.0 million, for an effective tax rate of 46.6% in the prior year period. The increase in the effective tax rate was primarily due to an increase in certain nondeductible expenses including: (1) nondeductible compensation, including stock-based compensation; (2) a $1.1 million expense related to an excess of cumulative compensation deductions over the realized tax benefit upon the exercise of employee stock options; and (3) the HIF imposed by the Health Reform Law beginning in 2014, which is treated as a nondeductible excise tax.


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